Regulate this

Posted by Marc Hodak on August 17, 2009 under Executive compensation | Be the First to Comment

Board capture Exhibit A:  Larry Ellison

Ellison routinely gets Wall Street sized bonuses for running a software firm of which he owns about 23%.  He is awarded millions of stock options each year, including 7 million new options in each of the last two years.  In 2007, that award alone was worth over $50 million.  Last year, the award was worth $71 million.  Now, a board with some say over compensation would ask two questions:

– If we didn’t give Larry 7 million options, would we be risking him leaving?  We probably shouldn’t be too concerned about Larry being snatched up by Microsoft or Sun, but would he even offer the credible threat of retiring?

– If we didn’t give Larry these 7 million options, would the shareholders suffer in some way from lack of alignment of his interests with theirs?  In other words, what alignment would 0.007 billion shares add to the other 1.173 billion shares that Larry already owns?

The most likely answer is that this board does not really have that much say over Larry Ellison’s compensation.

This would fit neatly into the widely accepted theory that boards in general are captured by their CEOs, willing to ignore shareholder concerns in favor of keeping the big guy (or gal, but usually guy) happy.  This theory or managerial power behind the topsy of regulations being proposed this year.

But is Ellison the rule or the exception?  Research suggests that he is the exception.  So, if board capture is the exception, do we as shareholders benefit from the new rules?  (Answer here.)  But that is a tired question.

Today, I ask a different question.  Would any of the new rules being proposed actually prevent the kind of agency costs/shareholder pilferage represented by exceptions like Ellison?

It is highly unlikely that the shares being showered on him serve any retention or alignment benefit.  But how, exactly, would mandating nominally independent directors help?  Oracle already has those.  What would shareholders have to say about his pay, especially given that he owns nearly a quarter of those shares?  Would they withhold votes for rest of the board if they ignored a non-binding vote against his pay?  Would Ellison care?

In fact, all captured boards share certain characteristics.  Their CEO has been around a long time–probably longer than any of them–so he benefits from multiple sources of authority.  The main source of authority is raw success.  You may not be surprised how hard it is to argue with extreme success, especially when measured in billions.  The captured board’s CEO is probably a celebrity, and has the kind of PR machine that your average director could merely dream of.  You don’t want to get in a public p*ss*ng match with this guy.

These characteristics of captured boards make it extremely difficult to contain their CEOs.  Short of mandatory retirement or terms limits (and imagine enforcing that on an Ellison, or a McNealy, or Hank Greenberg, etc.), there is little one can legislatively do keep such people in check.  Michael Eisner only became vulnerable when Disney’s performance lagged for about a decade, undermining that key source of his authority.

The average CEO who was appointed by the board within the last seven years.  His or her track record ranges from OK to pretty good.  People like this are already in pretty good check by their boards, and it’s a good bet that the market is driving their compensation.  For those firms–representing the vast majority of companies–all the new rules simply add cost and risk to the firm, which I really don’t appreciate as a shareholder.

So, I’m waiting to see how the new rules may contain Larry Ellison and his board.  I don’t doubt that Oracle’s shareholder suffer from overpaying their CEO, but they bought into this leaky bucket up front.  Ellison didn’t just appear one day and take over.  The costs of legislative and SEC attempts to keep his compensation in check may result in modest net savings for Oracle’s shareholders, but they are sure to add significant costs for the vast majority of the public company universe.